Emerging Market Investing: A Multi-Asset, Granular and Dynamic Portfolio Approach
Investors seldom include emerging markets in their strategic asset allocations. The authors argue that much of this skepticism is due to a period of weak returns, exacerbated by the suboptimal construction of the traditional market-cap benchmarks. Such indexes concentrate risk in single countries, are inconsistent across asset classes, and do not reflect the fundamentals of the underlying economies. Hence, the authors propose an asset allocation framework comprising two modules. The first module constructs a portfolio with balanced risk targeted across regions, countries, and asset classes. By geographically balancing risk, the portfolio is less vulnerable to the idiosyncratic shocks prevalent in emerging markets. Moreover, the resulting portfolio overweights lower-volatility bond markets, which not only exhibit higher risk-adjusted returns but are also less correlated with riskier assets. The second module introduces tilts based on expected returns within a tracking error budget. The authors demonstrate the benefit of incorporating expected return assumptions via systematic value- and carry-based tilting.
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The analysis contained in this paper is based on hypothetical modeling. Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program or strategy. One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading or modeling does not involve financial risk, and no hypothetical example can completely account for the impact of financial risk in actual trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses, are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results, all of which can adversely affect actual results. No guarantee is being made that the stated results will be achieved. Return assumptions are for illustrative purposes only and are not a prediction or a projection of return.
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